Multi-period credit portfolio selection

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Since the emergence of credit risk portfolio models in the 1990s, there has been a growing emphasis on active credit portfolio management among academics and practitioners. However, traditional active portfolio management, rooted in Markowitz’s work, primarily targets optimal portfolios for single periods, which may not suit traditional hold-to-maturity credit loan portfolios. In a multi-period context, an effective decision criterion that captures time preferences is essential, yet defining a proper multi-period utility function can prove challenging. Additionally, utility theory has limitations, particularly in establishing a common group preference. To address these issues, the author proposes a shift towards growth-oriented portfolio selection (GOPS), offering a viable alternative to the utility theory framework. This work provides a comprehensive overview of techniques for measuring and managing credit risk, including state-of-the-art methods for single periods. The GOPS model is illustrated through simple examples, enabling readers to grasp its specific properties for addressing particular credit portfolio problems. A significant advantage of the GOPS model is its compatibility with a bank-wide performance measurement framework, enhancing its practical applicability in the financial industry.